Trading emissions cuts: easy way out or sensible investment?

Under the carbon tax, Australia will be doing some of its emissions reductions overseas.

Australia is set to use international emissions trading to meet part of an emissions reduction target. Is this sensible and necessary? And how can we achieve investment in real reductions, rather than trading in empty promises?

To make our targets, we’ll look abroad

Treasury’s modelling has put the trading issue in the spotlight. In the core modelling scenario, almost two-thirds of Australia’s overall national emissions reductions for a -5% target take the form of “internationally sourced abatement”.

The modelling assumes that the most cost-effective reduction opportunities are used the world over, and countries then trade according to their respective emissions targets.

It is highly likely that Australia will be a net importer of emissions units, but the question is how large an importer.

Once a carbon price is in place, businesses could well find cheaper abatement options than assumed in the models. That has been the experience in the large majority of market-based schemes for pollution control.

Treasury’s core scenario has Australia importing 94 million tonnes of reductions in carbon dioxide during 2020, at an assumed carbon price of $29 per tonne. The value of the imported units would be in the region of $3 billion per year.

That is not much more than $100 per Australian per year, or about one large cappuccino a fortnight. But it is a considerable sum in absolute terms, and worth paying close attention to even if the actual amount is significantly lower.

How can you buy reduced emissions, and does it work?

What is meant by “imported emissions units” or “internationally sourced abatement”?

The idea is to invest money in emissions reductions activities in (typically) developing countries. These might for example be geothermal or hydropower, more efficient industrial plants, or reduced deforestation.

Meanwhile some hard-nosed critics see international emissions credits as dodgy pieces of paper from banana republics, and many on the deeply green end of the spectrum want domestic action first and foremost.

There are in fact doubts over the environmental effectiveness of parts of the Kyoto Protocol’s Clean Development Mechanism (CDM), which for the last six years has facilitated emissions reductions projects in developing countries. But more robust mechanisms could be designed.

Europe, whose companies are the main purchasers of credits from the CDM, is signalling it wants to move to schemes that would put whole sectors of developing countries under emissions limits. That would be a much more solid basis for trading.

Whose credits count?

For Australia, the question is which kind of emissions units will be allowed in the trading phase of the carbon pricing scheme, which starts in 2015.

Finance that flows from Australian emitters should result in real and lasting investments in mitigation in other countries.

The policy to be legislated now allows CDM credits. It also allows for changes to what credits are included in the future. So the CDM could be restricted, and new mechanisms allowed.

Environmental integrity and impact on prices in the Australian scheme figure prominently in the criteria for choosing credits. A price floor means Australia will keep a minimum carbon price no matter what prices are paid in possibly fragmented international markets.

New mechanisms to engage developing countries could be created under the UN umbrella, but whether this will happen in time is unclear.

An alternative would be to make arrangements among a group of likeminded countries in the Asia-Pacific region. Japan, Korea, California and New Zealand are all potential investors alongside Australia. A whole range of developing countries – among them Indonesia – could supply reductions.

Why not only cut emissions in Australia?

But why not simply stick with action in Australia? It would mean one of two things, neither of them a suitable response to the problem at hand.

The first option would be to implement a chosen carbon price domestically, not worry about meeting a national emission target, and therefore not trade. Unless prices are significantly higher than anticipated now, this might only slow or halt Australia’s emissions growth, not achieve reductions.

Other countries won’t see this as a commensurate contribution to the global effort.

The second option would be to enforce a chosen reduction target in a closed Australian emissions trading scheme, again without international trading.

The price would likely rise well above that in international markets, and the extra cost would be much larger than the cost of investing in emissions reductions overseas.

And under either scenario, Australia would fall short of its Copenhagen Accord commitment to help finance climate change action in developing countries.

The bottom line is this: economic logic dictates we should facilitate emissions cuts wherever they come at the lowest cost. Separately, the question of who pays for what needs to be dealt with.

Australia – as a rich, high-emissions country – is then going to finance reductions elsewhere. The challenge is to make sure that international carbon trading is not just economically attractive, but environmentally effective and promotes genuine involvement by developing countries.

Better mechanisms will be needed than those devised under the Kyoto Protocol, and Australia can play a role in making it happen.

Dr Frank Jotzo will discuss these issues at the Crawford School Dialogue – Australia’s carbon price: good policy or not? on Monday 5 September in Canberra.